On January 26, 1996, the Dutch Ministry of Finance issued a press release announcing a proposal for legislation which should:
a. improve the investment climate in The Netherlands from a tax point of view;
b. prevent the erosion of the taxable base of companies operating in the Netherlands.
The improvement measures concern:
1. a special tax regime for Dutch Finance Companies of multinationals.
2. the availability of a tax deduction for a decrease in value of shares of a loss-making subsidiary.
3. the possibility for Dutch subsidiaries of international groups to use their functional currency for the computations of their Dutch taxable income.
4. an exemption from tax for currency results on loans used to finance foreign participations.
The base erosion measures involve:
5. special rules for the allowance of interest deductions in situations where Dutch companies are acquired by way of (highly) leveraged acquisition companies.
6. disallowance of the deduction of interest on "artificially" created loans.
7. strict rules for the application of the participation exemption for group finance subsidiaries that lack sufficient substance.
Although not all details of the proposal for legislation have been made public, a number of the proposed changes may have an impact on the tax position and tax planning of international groups. The most important aspects of the proposal are discussed hereafter.
1. Special tax regime for Dutch Finance Companies
A Dutch Finance Company of an international group that is engaged in finance activities on behalf of other group companies can establish a reserve of 80% of the profits generated from its finance activities. Finance activities include short-term investments on funds maintained for potential take-overs. As a result of this reserve, the effective Dutch tax rate on the annual interest and other finance income will be only seven percent. A voluntary dissolution of the reserve at a later stage, over a five year period, is allowed at a special 10% tax rate.
A condition for establishing the reserve is that the Finance Company must perform activities on behalf of group companies located in at least four different countries or two different continents. It is rumored that the special regime will only be applicable if the Dutch Finance Company is the only finance company within the group.
A tax-free decrease of the reserve is allowed for the amount invested in companies that are engaged in certain (to be defined) innovative activities or in companies that are located in "politically or environmentally unstable areas"
A tax-free decrease of the reserve is also allowed for capital contributions relating to a claim on one of the group companies, which that company can not bear itself.
If losses are incurred on loans granted to group companies, a (taxable) decrease of the reserve will cover these losses. A taxable dissolution of the reserve is required when the Finance Company is liquidated or when the Finance Company is "transferred" out of the Netherlands.
The proposed Dutch Finance Company regime compares very favorably to other European finance companies like the Irish Dublin Dock companies and the Belgian Coordination Centres as the effective tax rate is low and the set-up and maintenance costs are only minimal compared to those of the "competition". The Dutch Finance Company will, therefore, be very attractive, not only for Dutch multinationals, but also for non-Dutch multinationals.
2. Tax Deduction on loss-making subsidiaries
Under the Dutch participation exemption, dividends received, and capital gains realised with respect to qualifying subsidiaries are exempt from tax. The participation exemption also covers a decrease in value or a loss incurred with respect to such subsidiary (unless the subsidiary is actually liquidated).
The proposal allows for a tax deductible depreciation of a 25% or more participation if the value of the participation decreases in the first five years after its acquisition or incorporation.
Once the subsidiary turns profitable, the amount of the depreciation will have to be recaptured. If the amount of the depreciation has not been (completely) recaptured in the first five years, the recapture will have to take place in the next five years.
3. Tax reporting in functional currency
Dutch subsidiaries of foreign multinationals will in the future be allowed to calculate their Dutch taxable income in the functional currency of the group. This will, obviously, reduce the administrative burden of internationally operating groups.
4. Tax exemption for currency results
Currency gains on loans taken up to finance foreign subsidiaries will no longer be taxable, as these gains will be covered by the participation exemption. On the other hand, currency losses on such loans will no longer result in a tax reduction. If requested, results on hedging instruments may also be brought under the scope of the participation exemption.
5. Restrictions on use of leveraged acquisition companies
A typical structure used for the acquisition of a Dutch target, is the acquisition through a highly leveraged, special purpose, acquisition company. By forming a fiscal unity (tax consolidation) between the acquisition company and the target, the interest payable by the acquisition company will be deductible against the profits of the Dutch target. The press release states that the interest deduction of the fiscal unity will be denied to the extent the acquisition company has a higher debt/equity ratio than the overall debt/equity ratio of the acquiring group. So far, no details are available on how this rule will be applied in practice.
6. Disallowance of artificially created interest deductions
Where debts are created as a result of the non-payment of declared dividends, the non-payment of a reduction of capital or the failure to pay a required capital contribution, the interest on those debts will not be deductible.
In a situation where a loan is granted by a group company to a Dutch company as part of an internal reorganisation, the interest on this loan will not be deductible, unless it can be shown that business reasons were the motivation for the reorganisation and the resulting loan. If there are no business reasons, but the interest on the loan is taxed in the hands of the recipient at a "reasonable" (probably 15%) rate, the interest deduction will be allowed, provided the recipient does not have loss carry forwards or other "entitlements" as a result of which the interest is effectively not taxed.
According to the press release, the other entitlements are tax credits for local or foreign (withholding) taxes, like for example the English advance corporation tax ("ACT"). The fact that the English ACT is referred to clearly indicates that the Dutch tax authorities do not fully comprehend the English tax system, as ACT can hardly be viewed as a tax credit reducing the effective tax rate.
7. Participation exemption for foreign companies
The application of the participation exemption on benefits from foreign finance companies, such as Netherlands Antilles Finance Companies, will be changed.
The participation exemption will only be available to companies that are actively engaged in financing of the group. The finance company will need to have sufficient substance. A foreign finance company will have to meet a number of criteria, which are yet to be specified.
Please note that the above is only a summary of a press release announcing proposed changes in the law. As it is anticipated that most of the proposed changes will actually be introduced, we want to inform you at this early stage of these proposals. We will keep you informed of further developments.
For more details, please contact John C. Brouwer at +31 20 574 1249.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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